If you’re investing through a limited liability company (LLC) and haven’t looked closely at your operating agreement—or worse, you downloaded a simple operating agreement for your LLC online—you could be setting yourself up for serious trouble.
I’ve been helping real estate investors for over two decades, and I’ve reviewed countless operating agreements. The scary truth? Many of them are riddled with critical mistakes that expose investors to lawsuits, tax headaches, and lost deals.
Let’s walk through the biggest issues I see in these so-called “standard” agreements. If you’re serious about protecting your investments, these are the details you need to pay attention to.
Explore the full breakdown in this in-depth video.
Generic Business Purpose Clauses That Don’t Hold Up
One of the most common red flags: vague business purpose clauses.
Most boilerplate LLC legal documents simply state that the company is authorized to engage in “any lawful business activity” without accounting for your actual business type—whether that’s a single-member LLC, multi-member LLC, or even a transition from a sole proprietorship. On the surface, that sounds fine, right?
But here’s the problem: if your LLC gets dragged into court, a judge or opposing counsel will comb through that agreement looking for weaknesses. A generic clause doesn’t show intent. It doesn’t prove that your LLC was set up for a specific purpose—like flipping properties, managing rentals, or trading securities.
Worse yet, some agreements only list what you’re not allowed to do, without clarifying what you can do. That leaves a massive gray area open to interpretation.
The Solution: Customize the business purpose. If your LLC is for real estate investing, say so. If you’re trading crypto, spell that out. Specificity strengthens your asset protection and makes third-party dealings much easier.
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Prohibiting Payments to Members or Managers
Here’s another hidden trap: language that explicitly prohibits payments to members or their controlled entities.
This is a nightmare if you’re trying to implement advanced tax strategies. For example, many investors use a management company to run their LLC and collect fees. It can lower taxable income and create additional deduction opportunities.
If your operating agreement says members can’t be paid or reimbursed, the IRS can use that against you. They’ll disallow those deductions during an audit, and you’ll be on the hook.
The Solution: Your agreement should say the LLC may compensate members or managers—not that it’s required, but that it’s allowed. Flexibility is key.
Missing or Misaligned Management Powers
If your LLC is manager-managed, you must clearly identify the manager and define their powers.
I’ve seen operating agreements where the manager is never named, and the agreement gives conflicting authority to both the members and the manager. That confusion can prevent you from opening bank or brokerage accounts, closing deals, or even signing checks.
Brokerage firms like Schwab or Fidelity will scrutinize your operating agreement line by line. If the management powers aren’t spelled out—including the authority to trade, sign, and act—they’ll deny your application.
In addition, certain state requirements may mandate clear language about management roles, and failure to meet those standards could result in rejection by banks or brokerage firms—or worse, loss of liability protection during litigation.
The Solution: Identify your manager by name or entity, and give them full, exclusive authority to manage the LLC’s operations, including financial transactions and investment activities.
Mandatory Annual Meeting Requirements
Some agreements require annual meetings of members—even if you’re the only member.
That might sound harmless until you forget to hold one. Now you’ve violated your own operating agreement, and a creditor or attorney can use that lapse to argue that you didn’t respect corporate formalities. That’s how they pierce the corporate veil.
The Solution: Say the members may hold annual meetings, but don’t make it mandatory. Avoid any provisions that create unnecessary compliance traps.
Giving Members Control Over Distributions
In a manager-managed LLC, it should be the manager who decides when and how distributions happen—not the members.
Requiring approval from all LLC members can backfire if you’ve gifted an ownership interest to a child, spouse, or partner. Now you’re forced to get their buy-in just to receive a profit distribution. In a multi-member LLC, this could stall operations. Default provisions often allow member control over distributions—but those default rules rarely support your goals or give the flexibility a manager-managed LLC needs.
The Solution: Keep distribution powers with the manager. It protects your ability to access income and ensures operational consistency.
Banking Authority Doesn’t Match the Structure
Your operating agreement needs to match how you actually run the business entity. If it says only members can sign checks, but the LLC is manager-managed, you’ve got a problem.
Banks won’t authorize signatory powers if your operating agreement contradicts itself or fails to clearly assign authority. This mistake often exposes your personal assets, especially in single-member LLCs, where courts may scrutinize whether you’re truly treating the business as a separate entity.
And if you sign on behalf of the LLC without proper authority, you could lose your liability protection in court.
The Solution: Align your banking language with your management structure. Make sure managers can sign, deposit, and handle day-to-day banking duties.
Missing Member and Manager Details
Shockingly, many operating agreements don’t even list who the members or managers are.
You can’t leave critical roles undefined and expect a court or a bank to honor your structure. This includes not only who the LLC owner is, but also the capital contributions each member made and the overall ownership structure of the company. These elements help validate your intent and can prevent disputes among members down the line.
The Solution: Always specify the names and roles of all members and managers, even if you’re wearing multiple hats.
No Charging Order or Creditor Protection Language
One of the main reasons to form an LLC in states like Nevada or Wyoming is to benefit from charging order protection. This limits a creditor’s ability to seize your LLC assets if you get sued personally.
But if your operating agreement doesn’t include this language—or reference Revenue Ruling 77-137, which allows you to allocate taxes to the creditor—they’ll miss out on that protection.
The Solution: Include specific charging order provisions and creditor deterrents in your agreement.
Why “Off-the-Shelf” Operating Agreements Can Be Dangerous
Most investors don’t realize just how critical their operating agreement is until it’s too late. A proper agreement isn’t just a formality—it’s an internal document that outlines ownership percentages, profits and losses, management duties, and how the business will operate under state law.
If you’re forming an LLC, you might be asking: Do I need an operating agreement? Even though some states don’t legally require LLCs to have one, the absence of an agreement can destroy your asset protection, especially in single-member LLCs. Courts look to see if you’ve respected your internal documents and business structure, and without one, your personal liability is at serious risk.
Many of the cheap services online ignore the nuances of your business structure. They’ll file your Articles of Organization with the Secretary of State, maybe assign a registered agent, and hand you a cookie-cutter document that misses critical protections—like how to handle distributions, resolve disputes, or protect your membership interest if you’re sued personally.
At Anderson Advisors, we go far beyond that. We custom-build every LLC operating agreement based on your specific activities, goals, and asset protection needs. If you’re wondering how to create an operating agreement for your LLC the right way, it starts with aligning your structure, tax election, and long-term strategy. Your agreement is a legal contract, and it should reflect more than just basic information—it should protect everything you’re building.
Want to Avoid These Mistakes?
Don’t wait for an audit or lawsuit to find out your operating agreement is flawed—or worse, invalid. You’ve already taken the step of forming an LLC. Now, make sure your operating agreement can back it up. Schedule a Free 45-Minute Strategy Session with one of our Senior Advisors. We’ll walk you through the right structure, ensure your Certificate of Formation, operating agreement, and internal controls all align with your goals—and make sure you’re not exposed to unnecessary personal liability. Book your session now.
